Best to be Unloved

By Craig Basinger, CFA

Everyone likes a good analyst upgrade on a stock they already own. Depending on the analyst, size of following, and size of firm, share prices certainly react to these changes of opinion. Think about this analyst rating change for a minute. Nothing has actually changed for the company: their business is the same as it was the day before the rating change, their risks are the same, even their cash flows are not impacted. Yet, overnight the value of their business just became a few percentage points higher or lower.

It did because the rating change elicits a behaviour of investors to buy or sell said company. Investing is fraught with uncertainty, but hearing someone (the analyst, legitimately an expert) likes something more, inclines the investor to like it more. We, as humans, are predisposed in a world that has risk, to stick together. It is how we survived when there was actual physical dangers from other species. It is how we endured during conflicts with other groups of people.

Yes, we are referring to investor behaviour from an analyst rating change as herd like behaviour. But we have also learned over the years that money is more often made by not following the herd. In fact, let’s see if we can support this view.

A look at analyst ratings

We ran an analysis over the past 10 years for the TSX and S&P 500, grouping companies based on how much they were loved or unloved by the analyst community. The calculation was based on the number of buy ratings on a given company as a percentage of the total number of analysts following a company. So, if it was 20%, that would mean 20% of analysts have a buy, with the remaining analysts at hold or sell.  From 2007 to 2017, we grouped companies each month into five groups, ranging from the most loved by analysts to the least loved. Then performance was calculated going forward until the next rebalancing.


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